Audit Risk Definition Model and Significance

What is Audit risk?

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.

Audit risk model and formula

Significance of Audit Risk:

An auditor is required to identify and assess the risks of material misstatements to provide a basis for designing and performing further audit procedures. The factors which an auditor should consider while evaluating the significance of audit risks are as following:

  • Whether the risk is a risk of fraud;
  • Whether the risk is related to recent significant economic, accounting or other developments and, therefore, requires specific attention;
  • The complexity of transactions;
  • Whether the risk involves significant transactions with related parties;
  • The degree of subjectivity in the measurement of financial information related to the risk; and
  • Whether the risk involves significant transactions that are outside the normal course of business for the entity, or that otherwise appear to be unusual.

Documentation of Audit Risk:

The matters which auditor would include while documenting the risk identification and risk assessment procedures are as follow:

The auditor shall include in the audit documentation:

  • The discussion among the engagement team about the susceptibility of the entity’s financial statements to material misstatement and decisions reached.
  • Key elements of the understanding obtained regarding each aspect of the entity and its environment and each internal control component; the sources of information from which the understanding was obtained; and the risk assessment procedures performed;
  • The identified and assessed risks of material misstatement; and
  • The risks identified, and related controls about which the auditor has obtained an understanding.

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